Huge debt levels in the US means a revaluation (strengthening) of the Yuan is unlikely to help America says Marc Faber, the famously bearish author of the famous Gloom, Doom and Boom Report. He was speaking on the last day of the Beijing CLSA China forum.
Interest payments on US debt held by foreigners already amount to almost 1.2% of GDP he noted. But this could double if the government is forced to put up interest rates to guard against inflation produced by more pricey Chinese imports. Import price inflation will be all the more serious if the dollar continues to weaken over the long term, as Faber believes it will.
Debt in the US has risen sharply on the back of negative real interest rates and investors leveraging off rapidly appreciating assets he pointed out. The background to rising debt was the fear of Japanese-style deflation by the Fed in the wake of the tech crash in 2001.
Based on the US experience with other currencies, a Yuan revaluation will not solve the country's problems. Faber said that Japan still has a huge trade surplus with the US even though the Yen has strengthened from 350 Yen to the US dollar in 1971, to around 107 currently.
The US also has a trade deficit with Europe, whose currency has recently been strengthening against that of the US dollar. Thus, from 2002 to 2003, the US trade deficit with Europe grew by 13% and the trade deficit for the first seven months of 2004 was 12% higher than the trade deficit for the same period in 2003
Faber concluded that the real problem with the US is an unhealthy type of economic growth, driven by consumption rather than wealth-generating capital expenditure. He said the capital expenditure figure has lagged in recent years, as has employment creation in areas other than low-end retail jobs.
According to Faber, US capital expenditure in 2004 recovered to around 7%. That is the same level as in 1993, compared to a level of 10% in the early 1980s. He believes it is no coincidence that the US has lost two million jobs since 1999 at the same time as China's market share of US imports rose to 6.5% in 2003, compared to less than 1% in 1990.
Faber highlighted how US manufacturing has been devastated in recent years, forming a steadily smaller portion of listed company profits. In contast, financial firms have seen enormous gains. Faber said this is a sign of speculation and inflationary asset prices.
Raising interest rates and slashing expenditure could bring long-term benefits to the economy, even as asset prices are pulled down to less inflationary levels. Yet Faber expects the US Federal Reserve to reverse its dollar strengthening policy if a serious economic correction threatens.
"A democratic government will ultimately always debase its currency to avoid its population suffering economic pain," he said.
Thus he believes that the bubble in real estate and stocks which has built up since 2000 is unlikely to show major reverses, although stock market gains will be capped by inflation.
"Price/earnings ratios tend to be compressed during periods of inflation," he said.
As the government prints money, asset prices in the US could continue to rise. But their value compared to other currencies could be very little. "We could see the Dow Jones go 100,000 points. But compared to gold or genuine hard currencies that would not mean wealth," he said.
Ironically, as far as global economic growth goes, Faber estimates that a weaker dollar is more beneficial, since it fuels US appetite for foreign imports.
The recent dollar strengthening trend, at least in the short term, "is bad for everything apart from the dollar itself," he noted, since by raising interest rates and slowing monetary expansion, the US government diminished liquidity to the rest of the world.
But while printing money will postpone the day of reckoning, Faber says that in the long term any country which lives beyond its means will end up paying the price.
